By Neil Hare
The old business adage that the time to fix the roof is when the sun is shining has never been more relevant than right now. Many businesses have seen a boost in activity over the last few months, but with the Delta variant still a threat and flu season officially underway, there may be yet another spike in Covid cases on the horizon. As this may result in new government restrictions, now is the time to access business capital that you may need later on, including considering debt financing options for your business.
During the pandemic, you likely found a way to keep your business afloat through pivoting, innovating, or accessing government relief funds like the Paycheck Protection Program (PPP), the Economic Injury Disaster Loan (EIDL), the Restaurant Revitalization Fund (RRF), or the Shuttered Venue Operators Grant (SVOG). But, those funds are likely dwindling if not completely, and you may be wondering, “What’s next?”
While you might not want to acquire more debt, that is likely the best bet for your business. There are no more federal grant programs on the horizon, and it is difficult to attract equity investors unless your business can scale quickly. And, even if you could attract equity investors, you would have to dilute your ownership in the business you built. While, of course, you have to repay debt, the advantage is you retain control of your business and typically can have a long time horizon to repay it.
The first step in applying for loans is to prepare your business finances. That means getting your books up to date so you can generate profit-and-loss statements and balance sheets, making sure your tax returns are as current as possible, and ensuring you have a future-looking business plan so you can explain how you plan to use funds. Many small businesses and independent contractors who were not prepared accordingly missed out on opportunities in the past.
Here are three debt financing options for your business that you can try to access:
1. Bank loans
Working with a full-service bank is still almost required to run a business and source debt capital. Again, a lesson learned from PPP was that those businesses with strong banking relationships—not just an account but a personal relationship with an account manager—were able to apply and secure PPP loans at a much easier and faster pace. In addition, those businesses with accounts at local banks, rather than national chains, also fared much better.
Banks will take a hard look at your credit score, business cash flow, last two years of tax returns, and planned use of funds before deciding on the size of a loan or line or credit, length of term, and interest rates. In many cases they will also want to collateralize your loan with either your businesses assets or, in some cases, your home. This means if you default on your loan, you’ll need to sell those assets or your home to repay the loan. It is a good idea to shop around for the right bank that can offer the best terms.
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Community development financial institutions (CDFIs) are also a good option if you live in an economically disadvantaged or underserved community. CDFIs are banks or credit unions, loan funds, and venture capital funds, whose goal is to broaden economic opportunity for low income and minority communities. These loans are more easily attainable, have lower interest rates, and come with business development help. The downside is the application times and receipt of funds can take much longer than banks or other funding sources.
2. Small Business Administration loans
There are several types of SBA loans:
Economic Injury Disaster Loans (EIDL)
The EIDL program is a traditional SBA program for areas of the country hit by natural disasters like hurricanes, fires, or other unforeseen events that devastate communities. In the case of Covid, the SBA determined the entire country was a disaster area, allowing every business to apply for these loans.
Applying for an EIDL loan is fairly easy and is done directly through the SBA website at www.sba.gov/eidl. The cap on EIDL loans is $500,000, with the typical loan around $150,000 with a 30-year repayment term. The money is meant for working capital to meet normal and customary expenses. Due to Covid, the SBA also instituted a two-year moratorium on the first payment, although interest does accrue. The interest rate on an EIDL loan is 3.5%, which is one of the lowest rates you will find. Non-profits may also qualify for an EIDL loan at a 2.5% interest rate. The Covid EIDL loans came with a grant portion as well that was $1,000 per employee up to 10 employees, or $10,000, although high demand reduced this amount to $1,000 regardless of your employee head count.
Due to the ongoing effects of Covid, EIDL loans are still available through December 31, 2021, and if you already received one, you may be eligible for an increased loan amount. If you are eligible for an increase to your existing EIDL loan, the SBA will contact you directly with more information and instructions, so be on the lookout for that email.
SBA 7(a) loans
The most common SBA loan is the 7(a) program, which can be used for short- and long-term working capital, refinancing of existing debt, and the purchase of furniture, fixtures, and supplies. These loans are most useful if real estate is part of the equation, such as for the purchase or construction of a new building or the renovation of an existing building. It is not required, however.
In order to apply, you’ll need the same paperwork basically required for a bank loan. This includes personal and business financial statements, such as balance sheets and profit-and-loss statements, tax returns, business licenses, and business plans, among other items. You apply for 7(a) loans through your bank and they are 85% guaranteed on loans up to $150,000 and 75% on loans greater than $150,000.
SBA 504 loans
SBA 504 loans provide long-term, fixed-rate financing of up to $5 million for major fixed assets that “promote business growth and job creation.” To be eligible for a 504 loan you must be doing business within the United States, have a net worth of less than $15 million, and have annual revenue after taxes of less than $5 million for the preceding two years. You apply for the loan through Certified Development Centers (CDCs), which are community partners of the SBA that promote economic development in their communities. The CDCs will also evaluate your business plan, management experience, and ability to repay the loan, among other factors.
The 504 loans can be used for the purchase or renovation of existing buildings or land, new facilities, or long-term machinery and equipment. They cannot be used for working capital or inventory, consolidating, repaying or refinancing debt, or speculation or investing in rental real estate. The loans can be repaid over a 10-, 20-, or 25-year term, and interest rates are automatically tied to a percentage above the current market interest rates for 5- and 10-year U.S. Treasury bonds.
3. Small business bonds
The SMBX, a new San Francisco-based fintech financing marketplace, has developed a platform for small and medium-sized businesses to issue bonds to their customers, community, and institutional investors. The company performs an underwriting service at no cost to determine how much credit the small business can qualify for, at what interest rate, and over how long a time horizon.
The capital raised ranges from $25,000 to as much as $5 million. Interest rates typically range between 4% and 10% and the time horizon is 1-10 years. The SMBX platform offers a couple of features that other lending programs do not.
First, if you borrow money from the SBA or a bank, you pay the principal and interest back to those entities. There is likely no other benefit to your business other than the loan. With SMBX your investors are your customers, and so every month they receive a reminder about your business when their principal and interest payment hits their account. Likewise, that capital stays within your community. Plus, even though your customers and community are not equity owners in your business as bonds are debt, they still feel the pride of ownership that can generate more sales and increased check sizes.
Second, the SMBX also provides free marketing around your bond offering. So once your business is listed on the exchange, the SMBX marketing team will provide email and social media marketing to your online followers. They provide messaging and creative development and can also provide flyers, mailers, or advertising copy. In many cases, businesses are seeing the marketing services they receive are of greater value than the cost of the capital borrowed.
Get capital for your business before you need it
It is highly unlikely that there will be a full shutdown of the economy again, or at least not in the majority of the country. That being said, many restrictions are already coming back and many businesses are still recovering from last year. It is critical to avoid being undercapitalized in this business environment. While the thought of taking on debt (or taking on more debt) may not sound appealing, it is still the best bet for small businesses to obtain the capital they need to maintain, grow, and thrive.
About the Author
Neil Hare is an attorney and President of GVC Strategies, where he specializes in small business policy, advocacy, and communications campaigns; follow him on Twitter @nehare and on LinkedIn. See more of Neil’s articles and full bio on AllBusiness.com.
This article was originally published on AllBusiness.com.